Wednesday, May 11, 2005

Part III: Some Like It Hot

When we left Grandma—our fictional “widows and orphans” investor who had looked to CEO Patrick Byrne to follow through on his promise to set “the gold standard in communicating with candor” to shareholders—she had been struck by the onset of a terrific headache.

Going through the big pile of shareholder letters and conference call transcripts, Grandma had discovered—far from the promised “gold standard”—a record of what seemed to her obvious flip-flops and turnarounds that made her increasingly nervous about the state of affairs within the company.

Anybody can tout a new product—as Byrne did with his auction site and his build-your-own-ring site—and be wrong, Grandma reasoned.

But to tell shareholders in letter after letter about how the company’s IT systems were “flexible” and “scaleable” and “leading edge,” and how this fellow Shawn Schwegman was a “star” and to brag that only five companies in the whole world had the same kind of large Oracle cluster something…

And then one day—just like that!—he says we can’t be doing things with hand calculators any more, and says that nice fellow Shawn had a word about their systems, he said they were “decrapitating.”

Decrapitating! Grandma pops another Tylenol just thinking about that word.

And all those people he used to brag about—that “team” and that “star” and he “could not be happier” with them—it turns out they were “nursing the systems along” and that ridiculous Oracle “cluster” had turned into “an enormous ball of spaghetti.”

Enormous ball of spaghetti! Grandma is shaking now. She picks up one of the reports from that nice man, the stock broker in Des Moines—it’s a report from something called WR Hambrecht—and reads it.

“The company is stepping up its IT hiring. All of this capex is designed to enable to scale to revenues of $4-8 billion.”

“What a load of manure,” Grandma says to the cat. “Patrick Byrne said it right in his conference call with those Wall Street flunkies, his systems are decrapitating. All that nonsense he spewed about Oracle-is-showing-us-a-lot-of-love (Grandma does like that Ellison fellow from Oracle) and then it turns out it’s “an enormous ball of spaghetti”

She looks at another report from a place called Piper Jaffray. The headline is Solid Revenues but Increasing Costs… “Not a word in here about their systems decrapitating,” Grandma tells the cat, tossing the report in the blue recycle bin at her feet.

She skims a third report, from Thomas Weisel Partners. “OSTK made significant expenditures on new IT systems, which the company believes is necessary [the boy can’t even write, Grandma muses] to handle future growth.”

Grandma drops it on top of the Piper Jaffray report. “Not a word about the enormous ball of spaghetti.” She ponders this for a moment. “This is a company that does all its business on the Internet, and says their systems are decrapitating. And yet none of these fellows on Wall Street are writing about it. I wonder why.”

She retrieves the reports. A sentence in the back of one catches her eye: “Piper Jaffray has received compensation for investment banking services from within the past 12 months.”

“No wonder,” she mutters. “And I thought they’d cleaned up that place, after Enron and Worldcom.”

Grandma sighs and tells the cat, “If you want something done right…” She takes a pad of paper out of the telephone drawer. It is the old, faded pad with the John Deere tractor on top, above the phone number for the Grange in Prairie City where Grandpa had worked.

She begins to set down all the nonsense she’s already read about—that “star” Shawn Schwegman and that “cluster” that only five companies have and that great “scaleable” and “flexible” technology…. It takes a while to get it all down and her wrist aches, but she keeps going, all the way through the “enormous ball of spaghetti.”

Then she looks for more. It does not take long to find it.

Overstock’s IT Programming Capabilities

Grandma reads about how Overstock does its own technology work:

Q3 2004 Call: We practice something called extreme programming, where we have very small teams of two or three people taking on enormous projects and it seems to be working.

That was in October, Grandma realizes. She reads on and sees that by April, just six months later, this Patrick Byrne was changing his tune:

Q1 2005 call: And here we’re tying to build a business that does a billion and 2 billion…we were stretching things very thin…. So this early February we just decided to pull the trigger. We had gotten everything pretty well architected and we just said we’re going to make these changes now.

The consultants and the teams have to come in and build it with us. And then we are hiring people within technology. No sense buying all this rocket scientist equipment and not having…enough rocket scientists to run it.

Grandma counts on her fingers: from October to February is just four months. “Just four months after talking about this extreme programming he says they were stretched thin and had to hire people!”

Grandma’s tired of reading about technology. She remembers the thing that nice broker had told her—about the new projects the Overstock people were working on…something about a travel web site. She finds it.

Overstock’s Travel Site

Q3 2003 Call: The travel store was launched to provide our customers a convenient and price competitive one stop shop for all of their needs…it is a work in progress.

Hmmm…Grandma shuffles papers, looking for the “travel store” that was “launched” in 2003, but finds no mention of it until this:

Q2 2004 Letter: Stormy Simon…responsible for our TV and radio commercials, our Book, Music, and Video, and our nascent travel department.

Grandma’s stomach is churning again. Is this one more of those “all hat, no cattle” things? Ah, here we go:

Q4 2004 Letter: Two more projects, Travel and Propeller, have made good progress.

“Good progress” sounds awfully vague, Grandma thinks. Sure enough:

Q4 2004 Call: On January 1st the [travel] tab went live again and now just has cruises, which are doing very nicely. You will see in the next four to 12 weeks, the rest of those categories fill in.

Hmmm…just as she thought. Promises, promises. She reads the April letter and her stomach settles down as she finds what she expected—more delays:
Q1 2005 letter: Travel — While cruises are live, the tab completion date slid from April to June.

“Figures,” she tells the cat. “If your technology systems are decrapitating, how on earth are you going to get all these great new products out the door?”

She glances back at that reference to “Propeller.” Hmmm….looks like another one of those phantom projects, she thinks. Let’s have some fun and see what happened to this one…

Project Propeller

Q3 2004 Letter: Propeller - Collaborative filtering. We have spent eight months building the system: we are in the initial stages of rolling it out.

Yes, Grandma thinks. I remember that now. It sounded impressive, whatever collaborative filtering is. Then she reads the transcript of the conference call from that very same quarter and is shocked—it doesn’t sound nearly so impressive:

Q3 2004 Call: We have finished a good first pass model for the collaborative filtering, and we're actually sort of testing it in different parts of our site this week.
“How about that!” Grandma says to the cat. “He writes to us shareholders we are in the initial stages of rolling it out…and then he goes and tells those knuckleheads on Wall Street we’re sort of testing it…”

She bangs her fist on the kitchen table. “What does he take me for?!” The cat jumps up, alarmed. Grandma mutters to herself “Rolling it out…sort of testing it…rolling it out…sort of testing it…” and reads on...

Q4 2004 Letter: "Propeller" (our statistical modeling engine) turned out to be too computationally intensive to be of use within our architecture: we re-architected our system to some degree, but not in time to go live in Q4. Doing so is our highest priority now.

Grandma no longer wears knickers, but if she did, she thinks, they be in a twist right now. She can not believe the twaddle she’s reading about “Project Propeller.” But it gets worse:

Q1 2005 Letter: Propeller -- Our collaborative filtering initiative is live and showing lift, but that is with flaws in the A/B testing that cause it to have a headwind. Once it is fully live and testing is improved, we should be able to tune it in (over the summer).

Grandma swats the cat off the table. She’s enraged at this nonsense: first it’s in the initial stages of roll-out…but it’s really just sort of testing…then it’s being re-architected, whatever the heck that means…then it has flaws in something called A/B testing…

Grandma remembers a line from her favorite movie, Some Like It Hot, when that playboy fast-talker Tony Curtis spins a tall tale to the sharp-tongued secretary he stood up on Saturday night, and then whispers in her ear,
“Nellie baby, I’ll make it up to you.”

Nellie eyes him suspiciously and says,

“You’re makin’ it up pretty good so far.”

But Grandma doesn't laugh. Instead, she finishes her notes, almost sick. She can’t take any more of this. It’s time to talk to a few people. She makes a list on the John Deere pad while the cat stretches and wonders what hit him.

The first on Grandma’s list is that nice man in Des Moines—the one who gave her all those reports for free, which turned out to be a lot of eye-wash. Next is her niece, the big shot analyst who works on Wall Street. Grandma doesn’t like to bother her niece, but this is important: she wants to understand how they can write all this nonsense and ignore what seems to be a problem in the technology systems this company needs to run its business.

And third on her list is her grandson in San Francisco—the one who works for that place she never quite understood what it meant…a hedge fund. He’s the skeptical one. Maybe he can help her.

Grandma wants to get to the bottom of all this.

Jeff Matthews
I Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.


goodwill said...

check out the 10q . these guys are writting covered calls like the old days. lost 10-15 million on it.

gvtucker said...

I think you're being a bit harsh on the Wall St analysts, Jeff. Of the 12 analysts that might be considered to actively follow OSTK, only 4 of them recommend OSTK, including 2 of the 3 you mention. If you read one of the analysts with a "sell" on OSTK, you'll note that the biggest issue he highlights is the heavy capex that will be necessary at OSTK. In aggregate, the Wall St analysts rate OSTK pretty low. Only 1/3 of the analysts recommend the stock, well below what would be considered normal.

Dan said...

Not sure if this has been posted yet, but I found it to an amusing

During the online retailer's quarterly conference call, Chief Executive Patrick Byrne was asked about the slow sales in early April after the company shed its $1 shipping rate.

"Maybe, though, on the other hand, maybe it's because the pope was sort of sick the 27th, 28th, 29th (of March) and then he died and then there was 10 days. And maybe that was what happened," Byrne replied.

Tom said...

Here's some good background on Patrick Byrne:

Jeff--out of six billion people in the world, are you comfortable that this one guy fully deserves your relentless bashing, day after day after day?

Is anything in this world worth more than a few extra dollars earned by short selling?

Jeff Matthews said...

Well, being a cancer survivor myself, that's a nice article and very inspiring.

What it has to do with his ethics in running a public company is not clear to me.

Chug-A-Bug said...

The quotes from Byrne and Overstock are fairly damning.

Instead of focusing on what a sympathetic guy Byrne may be, or castigating hedge funds and short sellers as evil, OSTK defenders should address the substance of the problems being identified in this blog.

If there is a reality-based, fact-based defense of this company, we haven't heard it yet.

mfairview said...

Jeff working overtime on his shorts.. Wonder if he was caught up in all this "rumor".


Hedgies in trouble
by: elan_lindsey 05/11/05 10:06 pm
Msg: 650846 of 650862

I had a really unusual phone call this afternoon. My broker rang and offered to convert my cash account to a margin account, so I'd have more buying power in the market. Gee, wasn't that nice of them? In the five years I've had this account, I've been cash, executed my own trades online and NEVER heard from a live person.

So I said, you know, it would be way to easy to get into a lot of trouble with margin, I'll pass.

THEN they asked if I'd loan my ELN shares, for a fee, of course.

That has NEVER happened. I declined, then took a stroll around Yahooland. Seems a lot of brokers are trying to borrow shares of a lot of equities. This is not ELN specific.

Something quite unusual is going on.

You know, when Kerkorian announced that he was going to buy a big chunk of GM at a premium to the current price, that was quite odd. Why wouldn't you just quietly accumulate until you *had* to report your holdings, in order to buy as cheap as you could for as long as you could? Why on earth would you make an announcement that is guaranteed to pop the pps?

So now we're hearing that some big hedgies who were short GM are in serious trouble. The begging brokers looking for shares to borrow are the first ripples in what may turn out to be a major short squeeze across the entire market, if those funds are forced to pay the piper.

The LTCM bail-out was a necessity, to prevent a global economic disaster. There was no other option. But the funds should have learned from that episode.

Now they've got caught over-leveraged on the wrong side of a trade, once again. Gee, so were a lot of ELN investors on Black Monday - was anyone scrambling to bail you guys out? I've had my nose bloodied a time or two by the Big Bad Bears. I say, let 'em burn. My shares are not for sale OR rent.

I wonder, though, was Kerkorian just looking to take a large position in GM, or was he looking to bloody a few noses himself?

Interesting times, indeed.

gvtucker said...

Your broker was looking to generate some more revenue from your account, nothing more. The biggest holder of ELN, Wellington, has enough shares by itself to take care of the entire short interest in ELN. And they lend out all of their shares. Same thing with GM. The biggest shareholder in GM, State Street, is more than able to take care of the entire short interest, and they also lend out their entire portfolio.

That isn't to say that there aren't hedge funds in some serious pain after April. But there isn't a short squeeze going on in equities any more than normal. The hedge funds in the most danger of blowing up aren't the regular long/short equity hedge funds you're talking about.